Skip to main content

Canada’s annual inflation rate eased more than expected to 5.9% in January, prompting markets and economists to revisit their expectations for what lies ahead for interest rates.

While a blowout Canadian jobs report for January spurred thoughts that a resilient economy may cause the Bank of Canada to hike interest rates at least one more time this year, today’s inflation report signaled that the central bank may stick to its guidance that further rate hikes are on hold for the time being.

Analysts polled by Reuters had expected annual inflation to edge down to 6.1% from 6.3% in December. Month over month, the consumer price index was up 0.5%, again lower than analysts’ forecast of a 0.7% gain after a 0.6% decline in December.

Excluding food and energy, prices rose 4.9% compared with a rise of 5.3% in December. The average of two of the Bank of Canada’s core measures of underlying inflation, CPI-median and CPI-trim, came in at 5.1% compared with 5.3% in December.

The Canadian dollar fell about a quarter of a cent on the data, to about 74 cents US. Shorter-term bond yields, which had been up sharply prior to the 830 am ET data in reaction to better-than-expected data overseas, also eased. The two-year bond yield, which is highly sensitive to changes in the Bank of Canada overnight rate, fell to about 4.21% from about 4.28%. (They returned to 4.28% by late afternoon, pressured higher by a jump in U.S. bond yields.)

Interest rate probabilities based on trading in swaps markets also immediately priced in lower odds that the Bank of Canada will hike interest rates further this year.

Prior to the data, they were pricing in a full quarter point hike in interest rates by this summer. Now, they are less certain, pricing in near equal odds of either a quarter point hike or no moves in the overnight rate at all for the remainder of this year.

Here’s how money markets are pricing in further moves in the Bank of Canada overnight rate for this year as of 9 am ET, according to data from Refinitiv Eikon.

Meeting DateImplied RateBasis Points

The current Bank of Canada overnight rate is 4.5%. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly.

Notice that credit markets continue to price in no cuts to the overnight rate this year - which is a change from a month ago before the release of a series of stronger-than-expected North American economic data, including the Canadian jobs report.

For the bank’s next policy rate decision on March 8, money markets suggest an 85% chance of no change in the overnight rate. The probability of a hike in the overnight rate, in the eyes of money markets, starts to increase modestly starting with the April policy rate decision.

Statistics Canada also released retail sales data this morning, showing a 0.5% decline in December, matching Street expectations. Market reaction, however, was much more tied to the inflation report.

Here’s how economists are reacting:

James Orlando, director and senior economist, TD Economics

January’s CPI report showed that inflation continues to cool in Canada. Headline and core measures are falling on a year-on-year basis and should decline even further over the coming months as the base effect of last year’s first half price surge washes out of the data.

For the Bank of Canada, it will need to see this trend continue for it to be comfortable remaining on the sidelines. ... A slowing in economic momentum will be needed for inflation to decisively fall back towards the 1% to 3% target range. The recent uptick in employment and spending data complicate this. But given the improvement in inflation data today, the BoC will not feel rushed to jump back in with another rate hike just yet.

Douglas Porter, chief economist with BMO Capital Markets

Today’s CPI represents a rare downside surprise in both headline and core inflation, clearly a big step in the right direction. While there were some one-off factors helping out, there were also numerous special factors on the way up last year - so we were due for some better inflation luck, with a cooling economy and improved supply chains also contributing. Even the short-term metrics on core inflation are getting into a much more manageable zone, which should soon trim the annual rates from their 5% perch. Overall, this milder report will provide the BoC with some comfort on their decision to move to a conditional pause, acting as a strong antidote to the run of robust growth figures seen in recent weeks.

Stephen Brown, deputy chief North America economist, Capital Economics

The much smaller rise in core prices in January suggests that headline inflation will fall faster than the Bank of Canada expects, reinforcing our view that the Bank is unlikely to resume raising interest rates. ...

Core prices rose by just 0.1% m/m, the smallest rise since February 2021. The 0.5% m/m fall in clothing prices is hard to square with the unseasonably warm weather, which should have boosted demand for full-priced spring clothing, but the 0.3% m/m fall in household operations, furnishings & equipment prices and the fall in vehicle prices – of more than 1% m/m by our seasonal adjustment – shows the positive impact of easing supply shortages.

The other good news is that the upward revisions to core inflation that Stats Can flagged last month were not as large as initially indicated, with CPI-median revised up by 0.2%-points in December and CPI-trim left unrevised. Either way, both fell by 0.2%-points in January as we had expected.

Andrew Grantham, senior economist, CIBC Capital Markets

A steeper deceleration in headline CPI than expected, largely due to some of the weakest core readings in almost two years, suggest that the Bank of Canada has already done enough to bring inflation under control. Although the annual rates of headline (5.9%) and core (around 5%) inflation remain well above the Bank’s 2% goal, those figures will look much lower by May as some of the largest monthly price increases from last year drop out of the annual calculation. Over the past three months, annualized rates of core inflation suggest that policymakers are already closing in on, or on some breakdowns have already met, their 2% target.

Alongside revisions to seasonally-adjusted price series, Statistics Canada also released for the first time a monthly profile for the Bank of Canada’s CPI-trim and CPI-median series. These are important as policymakers have been focusing on the 3-month annualized rate of change in these series, knowing full well that the annual rates (5.1% and 5.0% respectively) are still being influenced by big monthly increases last spring. The latest data suggest that the 3-month annualized rate for both were around 3.5% which, while still above the top end of the Bank’s 1-3% target band, is a big improvement from the peaks seen towards the middle of 2022. ...

Alongside some healthy readings for retail sales in December/January, the deceleration in CPI adds to evidence that the Bank of Canada doesn’t need to engineer a recession to get inflation under control. Headline inflation should ease below 3% by May, although continued strength in food prices and mortgage interest costs will likely keep the annual pace sticky between 2-3% throughout the second half of the year. That supports our call for no further interest rate hikes, but also no cuts until early 2024.

Matthieu Arseneau and Alexandra Ducharme, economists with National Bank Financial

Inflation data starts the year on the right foot. ... It is true that specific components contributed to January’s weakness, such as cell phone charges and auto prices, but core inflation measures that exclude the most volatile components in each month also point in the right direction. While still above the BoC target range, the recent trend is encouraging for the preferred measures of the central bank as evidenced by the three-month annualized variation of 3.5% for the CPI-Trim and 3.4% for the CPI-Med, their lowest growth since November 2021 and down from over 7% earlier this year. ...

This morning’s data comfort our view that the Bank of Canada should maintain its pause following the extremely aggressive tightening orchestrated in 2022. The actions taken so far will continue to dampen economic activity in the quarters ahead and, consequently, inflationary pressures. GDP and labour market has remained healthy lately, but the economic outlook is darkening with a sizable share of businesses expecting a drop in their volume sales according to January’s Business Outlook survey. The recent drop in active businesses do not bode well for hiring in the coming months. While it may take longer for the return to normal inflation levels on the service side, there is reason to believe that labour market will loosen up in a weak growth environment, contributing to a reduction in wage pressures. Meanwhile, we are very optimistic about goods where deflation cannot be ruled out as recent developments are encouraging, suggesting further moderation in price pressures. Higher inventories compared to earlier during the pandemic, significantly lower transportation costs, sales price cuts by Chinese producers and the global economic slowdown suggest a lull on the goods side.

Derek Holt, vice-president, Scotiabank Economics

The way I look at the figures was less dovish than what markets saw. First off, ignore year-over-year readings as they offering little if anything useful given how influenced they are by year-ago base effects. For instance, a year-ago saw Russia prepare to invade Ukraine and then do so which drove multiple commodity prices higher.

Secondly, trimmed mean and weighted median CPI measures of core inflation held firm at 3.7% m/m SAAR [seasonally adjusted annual rate] and 3.6% m/m SAAR respectively in January, thereby matching the December readings. They are faster readings than in November when they both dipped toward 3%, but not by much and they are still cooler than early last year when the rates were running at double that and more. Nevertheless, such rates of core inflation at the margin are cooler but not cool. ....

Quite frankly there are no BoC implications stemming from this report in my view. The BoC has made it clear they are on a conditional pause and that evaluating the condition will take more than a lousy 3–4 weeks and one or two inflation reports since they embraced it on January 25th. The March 8th statement should be short and sweet with no policy changes.

The bigger deal involves tracking progress on the drivers of inflation and actual inflation over a lengthier period. So far, there is no real evidence that Canada’s economy is opening up any disinflationary slack; in fact, it continues to look like the opposite case. The 2.9% q/q SAAR gain in hours worked that is tentatively being tracked for Q1 is a strong indication for GDP growth, given that GDP is defined as an identity by multiplying hours worked by labour productivity. If GDP growth continues to exceed estimates of potential GDP growth (the economy’s noninflationary speed limit) then the economy will continue to push further into excess aggregate demand conditions which is hardly compatible with sustainably lower inflation.